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Monday, April 25, 2016

My latest Macro Musing podcast is with John Cochrane, a Senior Fellow of the Hoover Institution and former professor of finance at the University of Chicago. In this week's episode I got to sit down and talk the fiscal theory of the price level (FTPL) with John Cochrane. I have been thinking a lot about FTPL lately--thanks in part to John's work on it--so it was a real treat to discuss it with him. We also got to chat about how he got into economics and the benefits of blogging for academics. It was a fascinating conversation throughout.

Here is a previous post I did on the FTPL that may be helpful in thinking about its implication. I also have a paper on FTPL coming out soon so stay posted.

You can listen to the podcast via iTunes or Sound Cloud, or through the embedded player above. And remember to subscribe since more guest are coming!

Monday, April 18, 2016

My latest Macro Musing podcast is with John Taylor of Stanford University. It was an interesting conversation throughout and we covered a lot of ground. We talked about the Taylor Rule, the Great Inflation, the housing boom period, the Great Recession, QE, the failure of the Fed to hit its inflation target, the international dimensions of Fed policy, rules versus discretion, and the latest efforts by Congress to nudge the Fed towards a more rules-based approach to monetary policy. A big thanks to John Taylor for being a part of the show!

You can listen to the podcast via iTunes, Stitcher, Sound Cloud, or the embedded player above. And remember to subscribe since more guest are coming!Related Links

Monday, April 11, 2016

Today is the launch of a new podcast series on macroeconomics called Macro Musing and I am privileged to be the host. Each week, with the help of a special guest, we will get to explore in depth various macroeconomic topics. If want to go all wonky on macro this is the podcast for you!

So far I have recorded podcasts with the following guests: Scott Sumner, John Taylor, John Cochrane, Cardiff Garcia, Miles Kimball, Ramesh Ponnuru, and George Selgin. There have been a lot of interesting conversations covering topics such as the origins of the Great Recession, the safe asset shortage problem, negative interest rates, the fiscal theory of the price level, the Eurozone Crisis, Abenomics, the Great Depression, China's economic problems, and alternative monetary regimes. In addition to these interesting topics, I have enjoyed learning how each guest got into macro, either as an academic or as an journalist, and how they see the field changing over time as new ideas and new technology emerge. I think you will find it fascinating too.

More guest are scheduled, including some Fed officials, but I would love to hear from you on what guests and topics you would like to see on the show. My first guest is Scott Sumner with whom I discuss his views on the Great Recession, NGDP targeting, and his new book on the Great Depression, The Midas Paradox.

I hope to make this a long-term project, but it success depends in part on you subscribing. So please subcribe via itunes or your favorite podcast app (update: here is the soundcloud link and here is the Stitcher link) and spread the word. Let's make this podcast a success together and who knows, maybe we can help make the world a better place.

Wednesday, April 6, 2016

The safe asset shortage problem is back. Actually, it never went away but drifted into the background as the symptoms of this problem--sluggish growth and low interest rates--became the norm. As the figure above shows, yields on government bonds considered safe assets have been steadily declining since the crisis broke out.

This problem is now manifesting itself in a new form: central banks tinkering with negative interest rates. Many view this development as the latest manifestation of central banks running amok. A more nuance read is that central banks are continuing to imperfectly respond to the safe asset shortage problem. The above figure indicates the downward march of global safe yields since 2008 is a global phenomenon. This decline has occurred outside of QE and prior to negative rates. It is a far bigger development than central banks playing with negative rates.

But many observers miss this point. They confuse the symptom--central bankers tinkering with negative interest rates--for the cause--the safe asset shortage. So I want to revisit the safe asset shortage problem in this post by reviewing what exactly it is, why it has persisted for so long, and what can be done to remedy it.

So what exactly is the safe asset shortage? It is the shortage of those assets that are highly liquid, expected to be stable in value, and used to facilitate exchange for institutional investors in the shadow banking system. They effectively function as money for institutional investors and include treasuries, agencies, commercial paper, and repos. During the crisis many of the privately issued safe assets disappeared erasing a large chunk of the shadow banking's money supply. This happened just as the demand for safe assets was increasing because of the panic. As recently shown by Caballero, Farhi, and Gourinchas (2016), if this excess demand for safe assets is big enough it will push down the natural interest rate below zero. Since the central bank cannot push its policy rate very far past 0%, an interest rate gap will emerge and cause output to fall below its potential. That seems to fit post-2008 fairly well. (HT Josh Hendrickson)

This problem can be illustrated by using a standard supply and demand graph for safe assets, as seen in the two figures below. These graphs are fairly standard except for the second vertical axis which allows me to show that interest rates move inversely with bond prices. The first figure shows the supply and demand of safe asset pre-2008. Note that interest rates are near 5% which is roughly where treasury yields were during that time.

Now comes the crisis in 2008 and two changes occur, as seen in the next figure. First, the demand for safe assets rises given the fear and uncertainty during the panic. This shifts the demand curve to the right. Second, the the supply of safe assets is reduced as many of the private-label safe assets disappear. This pushes the supply curve to the left.

Given these developments, two rather striking results emerge. First, because of the zero lower bound (ZLB), interest rates remain too high. The ZLB, therefore, acts as price floor that prevents the market from clearing along the interest rate dimension. Second, the ZLB also means safe asset prices are too low. It creates a price ceiling that prevents the market from clearing along the bond price dimension.

This implies treasury prices have been too low since the crisis!

Sometimes I am asked how can there be a safe asset shortage? Shouldn't safe asset prices simply adjust upward to meet the increase demand for them? The above analysis shows why this cannot happen with the ZLB. The safe asset market has been constrained by the ZLB and prevented from working its market-clearing magic.

Why has this problem persisted for so long? Why are safe assets yields still so low? I am not entirely sure. I suspect the demand for safe assets has remained elevated given the ongoing spate of bad news shocks since the crisis: Eurozone crisis, China concerns, fiscal cliff talks, 2016 recessions fears, etc. Also, some of the new banking and finance regulations is probably suppressing the growth of private-label safe assets. That is has taken this long, though, is a bit puzzling.

So what are the solutions to safe asset shortage problem? One solution is for the government to issue more safe assets. That the 10-year U.S. treasury is now 1.73% seven years after the crisis suggest there is still strong appetite for treasury securities. This is the solution proposed by folks like Stephen Williamson and Paul Krugman. Another solution is for policymakers to 'shock and awe' the public into believing a robust recovery is coming and thereby decrease their demand for safe assets. QE was supposed to do this but was not that effective. Scott Sumner and Michael Woodford's call for NGDP level targeting would also fall under this option. The final option is that policy makers could try to work past the ZLB via negative interest rates. Under this option policymakers would help the safe asset market clear by pushing interest rates and prices to their market-clearing levels.

As noted by Narayana Kocherlakota, the difficulty of doing the first two options seems to be making negative interest rates the default option. I am not convinced it will be very effective given how it is being implemented (very different than Miles Kimball's suggested approach). But it is a response--a groping in the dark by central bankers--to the deeper safe asset shortage problem. And that is something we all need to better understand.